Back in July, Bill King wrote up something called “SEC Induced Mother-of-All Short Covering Rallies.” Its all the more relevant today, and is repreinted with permission after the jump . . .
The King Report
M. Ramsey King Securities, Inc.
Friday July 18, 2008 – Issue 3912 “Independent View of the News”
There is one major reason for the scope of this rally: the SEC induced mother-of-all short covering rallies.
There are two minor reasons: 1) WFC’s accounting change on home equity loan delinquencies – from 120 days to 180 days; and 2) option expiration.
The SEC restricted ‘naked short selling’ years ago but it ignored stock delivery abuses for years. The reason that custodians and back offices are now in crisis mode, calling in stock, is fear that the SEC might enforce rules that it has ignored for years…The SEC created its ‘thresholds list’ of failed stock deliveries over a year ago.
SEC release April 11, 2005: Division of Market Regulation: Key Points About Regulation SHO
V. Answers to Frequently-Asked Questions from Investors
1. Is all naked short selling abusive or illegal?
When considering naked short selling, it is important to know which activity is the focus of discussion.
• Selling stock short without having located stock for delivery at settlement. This activity would violate Regulation SHO, except for short sales by market makers engaged in bona fide market making. Market makers do not have to locate stock before selling short, because they need to be able to provide liquidity. However, market makers are not excepted from Regulation SHO’s close-out and pre-borrow requirements.
• Selling stock short and failing to deliver shares at the time of settlement. This activity doesn’t necessarily violate any rules. There are legitimate reasons why a seller may fail to deliver on the scheduled settlement date.
• Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security’s price. This manipulative activity, in general, would violate various securities laws, including Rule 10b-5 under the Exchange Act. Regulation SHO does not address this issue.
SEC press release March 7, 2008: SEC Proposes Naked Short Selling Anti-Fraud Rule …proposing a rule that would specify that abusive and “naked” short selling is a fraud. (SEC release)
From the August 18, 2007 King Report: … a collateral problem is plaguing the global markets due to the mind-addling amount of financial engineering over the past decade. Ben isn’t cutting rates or unleashing helicopters because it wouldn’t alleviate the delivery problem.
2. A Street secret is that not only has lax regulation created derivative confirmation and settlement problems, securities of all types are failing globally because of excess arbitrage & pseudo-arbitration positions. There is a shortage of deliverable securities globally.
Securities in shortage command a premium. Those that have possession of the security, mostly banks
and brokers, benefit because they can demand a high cost to borrow the security.
This is a major reason that quants have gotten squished. Their short positions rallied not only on short covering from aggregate portfolio liquidation but also because their shorts were ‘bought in’ due to new SEC regulations and increasing Street back office fear about the burgeoning failures to deliver. On June 13, 2007, the day that the Bear Stearns hedge fund problem surfaced, the SEC voted to eliminate the short sale uptick rule and tighten delivery obligations. [even though the SEC knew the endemic naked short problems!]
Most Street denizens allowed the elimination of the short-sale uptick rule to eclipse the other rules that the SEC instituted. The Bingham law firm bulletin states, “…the SEC approved eliminating the grandfather exception from the close-out requirement of Regulation SHO and proposed to eliminate the options market maker exception from the close-out [of fails to deliver] requirement… In eliminating this exception, broker-dealers will now be required to close-out their fails within 13 days of a security becoming a threshold security regardless of when the sale or failure to deliver occurred.”
RGM Communication (Canada) 2001: Since at least the mid 1990’s, the SEC has been aware of naked short selling and has failed to adequately respond to investor and Company complaints alike. In recent years the Federal Bureau of Investigation, the Royal Canadian Mounted Police and the SEC have conducted numerous investigations into naked short selling and have followed these illegal stock sales through to money laundering and other illegal schemes. As a result of the lack of diligent enforcement of their own trading rules by the SEC, every private investor has had their financial integrity jeopardized… By their lack of enforcement and passive neglect, the SEC is therefore guilty of aiding and abetting criminal activities.
Since the SEC has failed to take adequate counter measures to stop illegal short selling and trading by members of the financial investment industry, we are demanding an independent examination by the United States Congress or Senate as to the reasons for their years of inaction.
Banks and brokers abused naked short selling and stock delivery fails for years; but perversely, now the
SEC is enforcing its rules in order to help the people that the exact rules the SEC ignored. This is just
more crony capitalism, socialism for the elites…Get long pitchfork and torch stocks!!!
Forbes, September 19, 2006: The U.S. Securities and Exchange Commission has received a deluge of requests to amend short-selling rules it enacted just two years ago…JPMorgan Chase has become the fifth bank to be censured and fined by the NYSE’s regulatory division for violations of trading rules meant to curb abusive short-selling…In July, Citigroup, Daiwa Securities, Goldman Sachs and Credit Suisse collectively paid $1.3 million for similar violations. They were the first firms to be slapped with a NYSE censure since the enactment of Reg SHO…
NYSE Reg says JPMorgan violated Regulation SHO, a rule put into effect in January 2005 by the SEC to curb abusive trading practices by limiting the ability of traders to do what’s called a naked short-sale, which is selling a stock they haven’t borrowed.
“We don’t have any power or legal authority to regulate or stop short-selling, naked or otherwise,” the DTCC says on its Web site. “We also have no power to force member firms to close out or resolve fails to deliver.”
Originally published at The Big Picture and reproduced here with the author’s permission.